Quit Playing the Loser's Game in 'Silly Season'

 | Jan 08, 2013 | 2:30 PM EST  | Comments
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Today we once again begin the quarterly silliness known as "earnings season." Traders will breathlessly huddle around the Bloomberg terminal and television as they await the next number to be released. Bets will be placed on the likelihood of a company hitting or missing the highly accurate Wall Street analyst estimates for the last three months. Meanwhile, investors and so-called strategists will be reviewing the data each day in order to try and come up with some sense of how corporate America is doing in the aggregate, and to forecast how the broader market will fare. Both of these last two endeavors strike me as being just an enormous waste of time.

My first thought about earnings season is that this is no way to run an economy. Publicly traded companies and their executives have developed an unhealthy devotion to quarterly numbers. An enormous amount of time and money is spent developing quarterly guidance to appease the casinos of lower Manhattan, when this could be devoted to activities actually involving running a business. A quarter is a blip in the lifespan of a corporation, and it's an absurd suggestion that a single three-month period should add or subtract tens of billions of overall market capitalization.

My second thought is that the silly season is a lot like a giant poker game with lots of bad players and a few good ones. The bad players make outright bets on numbers, whisper numbers and rumors. They shuffle large pots among them all season long, basing their bets more on luck than on skill. Any net gain or loss is an accident. Meanwhile, the good players use options to construct trades that profit from capturing the volatility the others create. They scoop small pots all night long. Guys like Real Money Pro contributor Tim Collins, who structure their trades around volatility, will find it hard not to giggle on the way home. If you must trade earnings season, learn from Tim and others: Trade the volatility, not the numbers and estimates.

That's not to say earnings season is worthless. I read the reports and keep track of changes in book value, trends in the business and debt levels -- and, in the case of banks, I look at changes in loan and asset quality. It is all valuable information, but it rarely spurs me to any immediate activity. What I'm worried about is what the stock will be worth next year or five years, and I only keep track of progress, or the lack thereof. To me, an earnings report is a still frame in a very long movie. It is rare that one three-month period will produce changes that significantly alter the value of one my portfolio companies.

I also watch a long list of stocks that trade at a slight premium to tangible book value. I hope these companies miss the quarterly numbers by a goodly margin, and that the stocks get hammered down to a decent discount to asset value. As the rest of the Street abandons the company due to a short-term focus and frenetic traders best the shares down, I shall embrace my inner vulture and be a buyer.

This earnings season, for example, I would love to see Huntington Bancorp (HBAN) miss that $0.17-per-share average estimate when it's due to report Jan. 17. I own some of this one, and I have a gain, but I would cheerfully sacrifice the short-term profits to buy more of the stock below $6. I am more concerned about my profit in Huntington in January of 2018 than I am in today's gains.

The same holds true for higher-yielding banks, such as People's United (PBCT) and Northwest Bancshares (NWBI). I would love to see one difficult quarter spark a wave of selling that allows me a chance to pick up shares of these at a discount to tangible book value. If I am lucky, the Street will treat a bad quarter like a casualty report -- and since my own work tells me the patient is actually pretty healthy, I can buy shares at a great price.

The list doesn't comprise just banks, either. Nissan (NSANY) is on my list at 1.3x tangible book value. I am hoping everyone bought Toyota (TM) last quarter, too. If everyone ate enough turkey in November, maybe Smithfield Foods (SFD) will miss the numbers when its report is due on March 13, and we'll see its share price tumble down to book value. Alcoa (AA) is set to report Tuesday night -- and I will not be upset if posts a horrific number that causes panicked sellers dump the shares, dragging prices below book value.

Most of my wishes and hopes for these stocks will remain exactly that. However, pretty much every quarter I will get one of my wish-list stocks to tumble down to the vulture-food level. Often that bad report will start an extended decline in a stock that eventually brings shares down into my valuation and buying range.

For an investor, the key to earnings season is the same as the key to long-term success in the markets generally: React to the situation the market creates, and quit trying to play the loser's game of guessing what might happen.

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